What is Consumption Based Licensing?

The best representation of this type of license is a service such as mobile phones. For years now consumers have paid for usage when it comes to mobile phone services. Starting with voice, you pay so much per month for each voice “minute” used. The currency can be different but typically the unit of measure is the same… minutes per currency. You don’t own the network and you don’t own the software that enables the voice traffic to traverse the many repeaters, routers and uplinks, but you still get the service… every month with a similar Service Level Agreement. This is a pay-as-you-go or pay-as-you-consume minutes model. Mobile phone usage provides a basic definition for Consumption Based Licensing.

The next phase of licensing in the mobile phone market was to set a “term” for usage. The phone company asked the consumer to pay a set amount based on a number of used minutes in a fixed number of months (usually a 12 or 24 month “term”). So the contract was a certain currency per month for a maximum number of voice minutes over a 12 or 24 month term. If the consumer used more than the allocated minutes, the usage reverted back to a pay-as-you-go model. Certainly the currency for usage for this “overage” was a premium because the usage was not a part of the “Term” contract.

Phone companies next introduced data services called “text messaging” which started once again in a pay-as-you-go (or consumption based) model. Each text message cost a certain amount of currency. Once the market became established a new contract was set in place again based on a term. For “n” number of text messages per month a fixed fee was allocated over a certain term (once again usually 12 or 24 months).

These services are a good representation for a consumption licensing model. The business implications of such a licensing model are not as straight forward. For instance a simple calculation of owning an asset versus renting it (or using it as it is consumed) carries some interesting implications. Take for instance the asset we call software. The government allows corporations to depreciate their assets as a portion of their costs. Assets (whether software or hardware) carry with them a schedule of depreciation that spans a term of time (usually between 3 to 5 years… sometimes longer). These assets are considered “capital” and are depreciated because they lose their value over time. The depreciated asset is a part of what most accountants would call the Capital Expense portion of a profit and loss statement.

Assets that are not owned (leased or rented) may not be depreciated because they are typically a monthly expense. These expenses become a part of the Operating costs of a business and are usually represented as an “operational expense“. The advantage of purchasing assets versus renting or buying them is that the business can continue to use the asset even after it has been fully depreciated and so there is a tax benefit for the depreciation taken off of the balance sheet but the asset remains valuable all the way through its life even after being “fully” depreciated.

If all of this sounds complex… IT IS! The important thing to understand is that capital assets are fixed costs. They are an asset that is owned and the company that purchases the asset also purchases the liability of that asset (i.e. its depreciated or loss of value). When renting or leasing an asset the cost is variable in that it only hits the balance sheet during the period of use. In most cases this is month by month. Assets that are purchased in this way would be considered pay-as-you-go or consumption based.

Why is all of this accounting so important to running a business when you are considering consumption based licenses? Because the state of your business will often times dictate how you are going to pay for an asset. For instance, if you have a growing business and you are “cash poor” (not a good deal of cash in the bank) you may want to use a consumption model to pay for your assets and use the cash on hand for hiring additional people (expanding your payroll)… something you can’t pay over extended periods of time. In this case, cash flow may in fact demand that you use a consumption model.

Another reason to use a consumption based pricing model is to insure your assets are on the Operational Expense side of your balance sheet. This allows you to show the asset as a cost on a monthly basis and not a depreciated cost over several years. You may save additionally on maintenance of that asset because you don’t own it. If it becomes worn out or obsolete, you simply rent/lease the newer item.

All of this is to say that simple comparisons for costing capital based assets versus consumption based assets may not be valid unless you take into account all of the elements of the business. Cash flow, cost of currency (inflation), rapid growth and asset depreciation all must be considered when deciding on consumption versus capital models.

An example of this difference is the Microsoft SPLA program program. Assets (Microsoft software) that were once considered capital can now be relegated to the Operations Expense of a company by having third party hosting companies “rent” the software to you. Hosting companies in the CSP program work the same way.

Share

Tagged under:

Scott Swanburg has been involved with innovation and building businesses in the Internet for the past 30 years. From Fortune 50 companies such as AT&T to start-up ventures, he has actively changed the playing field for the delivery of applications and data to millions of subscribers around the world. For the first half of his career, he managed and directed teams in Software and Systems Engineering. The past ten years, he has been helping technology companies drive net new revenues in Sales, Marketing and Business Development.